Why are banks hesitant to lend to MSE sector with CGTMSE coverage?

MSME sector (Micro, Small and Medium Enterprises sector) plays a crucial role in improving Gross Domestic Product (GDP), creation of employment opportunities and export growth in India. The sector contributes around 30% of GDP, 40% of exports apart from creating jobs for about 11 crore people. Of the total bank credit outstanding of more than Rupees 100 lakh crores, Rs. 29 lakh crore is towards MSME sector.

Considering the importance of MSME sector, Credit Guarantee Scheme (CGS) launched by CGTMSE and Government Of India provides guarantee coverage to banks to extend collateral/ third party guarantee free credit facilities to MSE sectors. Further, of the Rs 20 lakh crore Covid-19 economic package announced the Prime Minister toward Atmanirbhar Bharat Yojna, Rs 3 lakh crore has been earmarked for collateral-free loan scheme for micro, small and medium enterprises (MSMEs). Despite all these announcements, collateral free loan schemes with CGTMSE coverage has not been a favourite among bankers. This article covers the challenges before the banks while extending loans to MSE sector with CGTMSE coverage.

CGTMSE coverage and challenges for banks

There are mainly six reasons for banks becoming highly selective in extending credit facilities to MSE borrowers under CGS. The root cause of some of these can be noted in the scheme norms published by CGTMSE itself.

1. The MSME sector is a highly vulnerable sector. The already existing Rs. 29 lakh crore exposure to MSME sector contributes heavily for the non-performing assets (NPAs) of banks. Around 9-10 percent of NPAs of banks are from this segment and it is sufficient reason for banks to reduce exposure to the segment. Even in the loans secured by collaterals, banks find it difficult to recover full amount because of the deterioration in economic conditions and subsequent erosion in collateral values Higher NPA weakens the balance sheets of banks and banks will have to pump additional capital which is a great challenge in unfavourable economic conditions.

2. Under the Credit Guarantee Scheme banks must exercise all due diligence as applicable in the case of other normal lending and shall ascertain project viability. However, strong push by politicians and coverage by certain overenthusiastic media create the impression among the public that the government extends guarantee to the banks on liberal terms and that banks are denying the MSE sector what is due to them. Borrowers under this false impression, approach the banks without much homework, proper project and fails to establish the viability. The disciplinary actions on bank officials for failed projects add to the woes of bank officials.

3. In the case of failed projects, the loss compensated by CGTMSE to the banks is 50/75/80/85 per cent of the credit facility. Major part of coverage falls under 75% category and the remaining loss (25% credit facility) has to be absorbed by banks.

Often PSU banks are under pressure to meet the targets set by the government to make the MSME loan scheme a success, forcing banks to overlook the creditworthiness of the borrower to meet the heavy targets. Sometimes, bankers face political pressure at local level to give loans to unworthy, politically connected borrowers. This increases the stress in the portfolio and consequent loss to the bank which compels them to deny eligible proposals.

4. Claim under guarantee can be enforced only after satisfying many conditions. Banks can approach CGTMSE for claims only after all required legal actions for recovery are initiated by the bank (except for small loans upto Rs. 50,000 subject to certain conditions). The trust shall pay only 75% of admitted claims initially. The balance 25% will be paid only on conclusion of recovery proceedings or after initiation of SARFAESI proceedings. This causes the NPA to remain in the balance sheet for long thereby weakening the balance sheet of banks.

5. CGTMSE follows differential risk based pricing for lenders depending upon claim payout. Additional risk premium of 15% will be charged on the applicable rate to lenders who exceed the pay-out threshold limit of 2 times more than the guarantee fee paid, thrice in last 5 years. Higher premium will be applicable for all guaranteed accounts irrespective of the conduct of account. Charging higher fee to well operated accounts becomes a challenge for banks. In addition, higher premium compels genuine borrowers to approach other banks with lower premium. To minimise losses and the premium, banks become very choosy.

6. MSME sector mainly supply their products to major players. However, when the economic conditions go wrong, survival of even big players faces challenges and the demand for the products of MSME sector goes down. Lack of enough capital causes their failure much faster. The failure in turn affects their own future prospects. Under unfavourable circumstances, genuine MSME borrowers explore opportunities to reduce the debt rather than increasing indebtedness despite the presence of guarantee coverage.